Let's Get Fiscal

Nevada has one of the highest unemployment rates in the US. Shelters are so overcrowded that homeless tent cities are developing in view of the casinos in downtown Reno. (Photo: Getty)

The Dow is surging! No, it's plunging! No, it's surging! No, it's ...

Nevermind. While the manic-depressive stock market is dominating the headlines,
the more important story is the grim news coming in about the real economy.
It's now clear that rescuing the banks is just the beginning: the nonfinancial
economy is also in desperate need of help.

And to provide that help, we're going to have to put some prejudices aside.
It's politically fashionable to rant against government spending and demand
fiscal responsibility. But right now, increased government spending is just
what the doctor ordered, and concerns about the budget deficit should be put
on hold.

Before I get there, let's talk about the economic situation.

Just this week, we learned that retail sales have fallen off a cliff, and so
has industrial production. Unemployment claims are at steep-recession levels,
and the Philadelphia Fed's manufacturing index is falling at the fastest pace
in almost 20 years. All signs point to an economic slump that will be nasty,
brutish - and long.

How nasty? The unemployment rate is already above 6 percent (and broader measures
of underemployment are in double digits). It's now virtually certain that the
unemployment rate will go above 7 percent, and quite possibly above 8 percent,
making this the worst recession in a quarter-century.

And how long? It could be very long indeed.

Think about what happened in the last recession, which followed the bursting
of the late-1990s technology bubble. On the surface, the policy response to
that recession looks like a success story. Although there were widespread fears
that the United States would experience a Japanese-style "lost decade,"
that didn't happen: the Federal Reserve was able to engineer a recovery from
that recession by cutting interest rates.

But the truth is that we were looking Japanese for quite a while: the Fed had
a hard time getting traction. Despite repeated interest rate cuts, which eventually
brought the federal funds rate down to just 1 percent, the unemployment rate
just kept on rising; it was more than two years before the job picture started
to improve. And when a convincing recovery finally did come, it was only because
Alan Greenspan had managed to replace the technology bubble with a housing bubble.

Now the housing bubble has burst in turn, leaving the financial landscape strewn
with wreckage. Even if the ongoing efforts to rescue the banking system and
unfreeze the credit markets work - and while it's early days yet, the
initial results have been disappointing - it's hard to see housing making
a comeback any time soon. And if there's another bubble waiting to happen, it's
not obvious. So the Fed will find it even harder to get traction this time.

In other words, there's not much Ben Bernanke can do for the economy. He can
and should cut interest rates even more - but nobody expects this to do
more than provide a slight economic boost.

On the other hand, there's a lot the federal government can do for the economy.
It can provide extended benefits to the unemployed, which will both help distressed
families cope and put money in the hands of people likely to spend it. It can
provide emergency aid to state and local governments, so that they aren't forced
into steep spending cuts that both degrade public services and destroy jobs.
It can buy up mortgages (but not at face value, as John McCain has proposed)
and restructure the terms to help families stay in their homes.

And this is also a good time to engage in some serious infrastructure spending,
which the country badly needs in any case. The usual argument against public
works as economic stimulus is that they take too long: by the time you get around
to repairing that bridge and upgrading that rail line, the slump is over and
the stimulus isn't needed. Well, that argument has no force now, since the chances
that this slump will be over anytime soon are virtually nil. So let's get those
projects rolling.

Will the next administration do what's needed to deal with the economic slump?
Not if Mr. McCain pulls off an upset. What we need right now is more government
spending - but when Mr. McCain was asked in one of the debates how he
would deal with the economic crisis, he answered: "Well, the first thing
we have to do is get spending under control."

If Barack Obama becomes president, he won't have the same knee-jerk opposition
to spending. But he will face a chorus of inside-the-Beltway types telling him
that he has to be responsible, that the big deficits the government will run
next year if it does the right thing are unacceptable.

He should ignore that chorus. The responsible thing, right now, is to give
the economy the help it needs. Now is not the time to worry about the deficit.